The Weekly Standard
January 16, 2012
by Irwin Stelzer
America's more or less free-market capitalism is not under threat from Marxist-Leninism: That system's demonstrated failures have consigned it to the ash-heap of history. Nor is it under threat from China's system of managed economy plus political repression: We can't even abide police breaking up a disease-infested occupy-something-or-other encampment. It is not even under threat from socialism, the hysterical charges of some anti-Obama extremists notwithstanding.
No, it faces a far more subtle enemy—the gradual loss of acceptance of the idea that markets more efficiently allocate resources than governments, of the parallel idea that properly but not excessively regulated markets produce unparalleled levels of material wellbeing (something Marx conceded), and, finally, of the conviction that material prosperity is fairly shared among all who participate in its creation, with enough left over to care for those too ill, old, or otherwise impaired to participate in productive activity. When the broad consensus erodes that capitalism as practiced in America is better at creating and distributing wealth than any other system, the way is open for fundamental legislative and regulatory changes that strip the system of its flexibility and innovative drive.
Which is what makes the behavior of the leaders of our financial sector so inexplicable. Start with a few widely agreed facts. The financial sector does not have a recent history of which it can be proud. Investment banks bet their own money that the mortgage bubble would burst while at the same time advising their clients to buy mortgage-backed securities. Managers of our largest banks took on risks they did not understand, safe in the knowledge that they were too big to fail—that the government would have no choice but to bail them out in order to avoid a cataclysm, or at least a deep recession.
Compensation was decoupled from performance, with failed executives tottering off onto their country clubs' golf courses after pocketing multimillion-dollar bonuses and being awarded the use of company jets and office facilities.
Some idea of the mindset of the leaders of the financial community can be gleaned from their response to criticism. Lloyd Blankfein, head of Goldman Sachs, claimed to be doing "God's work," a linking of God and Mammon that might have come as a surprise to the Lord. Charles "Chuck" Prince III, soon to be defrocked as CEO of Citigroup and sent packing with multimillions in payoffs, pensions, and perks after a reported $64 billion decline in the value of the bank over which he presided, explained the intellectually demanding risk analysis techniques he applied in his work: "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing." So were the passengers on the Titanic when it hit that iceberg.
Meanwhile, income inequality increased. We are not sure of all the reasons for this development, but we do know that it is in part because globalization brought millions of dollar-a-day workers into the international economy to compete with American workers; in part because the premium for skills and training was rising as the political class ceded control of the American education system to dirigiste teachers' unions that prevented needed adaptations to the new world; and in part because money talks in the rooms in which the tax code is twisted to the advantage of special interests. Worse, mobility fell, creating an atmosphere ripe for an embattled president to declare class war rather than take on entrenched interests, i.e., unions fighting to prevent entry into trades and to preserve extortionate pensions; bankers willing to pour millions into Obama's campaign coffers in return for prestigious photo-ops and appointments to meaningless committees; billionaires pressing him to increase taxes on families with relatively modest incomes while their capital gains and deal-generated profits receive gentler treatment at the hands of the tax collector.
None of these ills seems curable in the face of entrenched opposition by members of the financial and business communities, and other interest groups. The Democrats quite predictably defend the trade unions that fund them, and what they see as the disadvantaged, never mind that that group now includes wealthy older people who would be offended if their Social Security and medical benefits were reduced a trifle by means testing. The Republicans see no reason why the very, very wealthy should have their tax burden increased a bit, their corporate clients should lose their special tax benefits, or the lucky winners of the gene lottery should pay higher taxes on their inheritances. The result of this crony capitalism—each party with its own cronies—is a lack of radicalism, a you-don't-gore-my-ox-and-I-won't-touch-your-sacred-cow system.
Enough whining. As Lenin asked, "What is to be done?" Voter action at the polls is clearly indicated, although the appalling lack of choice—a Democrat wedded to the economics of the past, and either a clearly nutty or a cautious, establishment Republican technocrat—suggests that the radical change the moment calls for will not come from the political class, at least until the young Turks in the Republican party mature while, we hope, remaining, well, young Turks. So what is to be done is what can be done—remove some of the most glaring defects in the capitalist system, starting with the financial sector. That will take conservative support for change—support not only from the conservative punditry, but from the business community.
Recall: The titans of finance are not well positioned to display a lack of sympathy for those suffering from the consequences of their errors. They still hold their jobs only because the taxpayers bailed them out, with the Fed providing $1.2 trillion of public money on top of other bailout funds, the alternative—watching the financial system melt down—being too gruesome to contemplate. No good saying that without Wall Street there would be no Main Street. The facts are that Main Street is littered with shuttered shops, while appallingly managed banks have survived, and that the foreclosure rate in Greenwich, Connecticut, the preferred home of hedge fund managers and those financial executives who prefer sweeping lawns to the sweeping penthouse views favored by some of their colleagues, is far below the national average.
Yet, pick up your daily paper for the sort of anecdotes that sometimes trump data. Bank of America hires a debt collection agency that a Florida judge finds illegally harasses widows to pay the credit-card debts of their deceased husbands. Here is part of the report in the Wall Street Journal:
Bank of America and other major U.S. lenders hand over accounts of the deceased to firms specializing in death-debt collection. The collection firms then zero in on family members who they think might agree to pay some of what the dead person owed even though they have no legal obligation to do so .??.??. duping relatives into thinking they have to pay the debts of the deceased.
One anecdote should not be the basis of policy. But such an anecdote backed by numerous tales of homeowners who failed in their attempts to negotiate easier terms so as to avoid foreclosure tells something about the insensitivity of leading bankers to the threat posed to the capitalist system by the difficulties faced by millions of Americans. These bankers might do well to cast an eye over the magazine rack of their local newsstand, where Consumer Reports's cover blares, "Fight Back Against Your Bank." We're not talking the Nation or the New Republic here, but the stuff which middle-class America reads.
Sure, it is easy to say people should never have bought homes they cannot afford. But many of these people could indeed afford those homes in the opinion of the banks that lent them the money, before securitizing their mortgages into bundles that the rating agencies saw as virtually riskless—triple-A rated—and passing them off to investors. Many were simply the victims of a financial calamity they did not produce, others of globalization and inept trade policy that allowed China's currency manipulators to destroy their jobs, still others of government programs that lured them into buying homes that would prove beyond their means, especially when the low, starter-interest rates willingly offered by the banks ratcheted up.
The odd part of the banks' preference for foreclosure over mortgage restructuring is that they end up with houses they cannot manage and lawns they cannot mow, properties that become rundown with dire consequences for entire blocks and neighborhoods, and that end up being sold for a fraction of their value. True, foreclosure does avoid moral hazard, an advantage not to be ignored. But that advantage has to be weighed against the costs of a wave of foreclosures. I wonder if those bankers, with the wisdom of hindsight, would have preferred a bit of moral hazard to the failure of Lehman Brothers. Most important is the failure of the bankers to ask themselves what sort of policy towards foreclosures is consistent with the long-term acceptability and survival of American capitalism. And the failure of Republican politicians to ask themselves just why they support banks' opposition to allowing bankruptcy judges to include mortgage obligations when they restructure the debts of those seeking bankruptcy protection, as many Democrats propose. Executives of American Airlines are applauded by the financial community for their shrewd use of the bankruptcy laws to get out from under their contractual obligations. Homeowners who do the same thing are considered immoral.
Most surprising are the objections of leaders of the banking community to quite sensible reforms, their willingness to sacrifice long-term support for the market system to the desire for short-term profits. It is true, for example, that higher capital requirements for banks, requirements that "don't go nearly far enough" according to John Cochrane, finance professor at the University of Chicago, will reduce their profits. That is so—but only because requiring banks to hold more capital reduces the risk of failure or the need for bailouts, risks that have until now been borne by taxpayers.
Also difficult to understand is their failure to comprehend that some practices, such as imposing retroactive increases in interest rates on bank credit cards, are deeply objectionable to consumers, even if technically justifiable. And their failure to realize that large bonuses at a time when 25 million Americans can't find any or enough work are an excess they might want to forgo in the interests of maintaining support for the system that has been kind to them—including bailing them out when they hit the rocks. One investment bank warned its highflyers not to be seen in Porsche showrooms, so it's not as if these bonus recipients are unaware that something potentially unpleasant is brewing out there in the world beyond their office towers.
Bankers are not alone in their failure to understand that something must be done to prevent the opposition to many features of the current system from creating an atmosphere that will support "reforms" so draconian that the resulting system will retain few of the virtues of the existing one. The corpocracy at times seems equally obtuse, as when its leaders call for repeal of the provisions of the Sarbanes-Oxley law that make it easier for shareholders to rid themselves of underperforming directors, and require that directors be truly independent, rather than chums of the CEO, especially when serving on compensation committees. The breaking of the link between performance and reward that results from friends-of-the-CEO boards of directors does as much to undermine capitalism's claim to legitimacy as financiers' obtuseness about their responsibility to act as if they are members of a society that extends beyond executive dining rooms and country clubs.
I am not one who sees in the Occupiers the wave of the future. They are not the real worry to those of us who fear for the future of market capitalism in America. It is the failure of the major beneficiaries of the capitalist system to understand that openness to reform, combined with a bit of restraint when carving up the huge pie that capitalism is capable of producing, is the best way to head off those people who would alter market capitalism beyond recognition by imposing punitive taxes, onerous regulations, investment-distorting subsidies, along with a bloated government. Those folks are dangerous enough to America's future prosperity without being handed the gift of obtuse opposition to needed change.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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